Labour and the pensions black hole

THE greatest domestic betrayal by the Blair Government has been its flagrant neglect of pensions policy. In the years following the Second World War, the Labour Party promised a shattered British people 'cradle to grave' protection paid for by National Insurance contributions. Now it has, in effect, reneged on its social contract with the nation.

The authoritative Pensions Commission is telling us, rather than the Government, that we must adjust our behaviour if a terrible burden of £57bn a year is not to fall on the public purse. The only way we can avoid this nightmare for the public finances, according to the Commission, is to make a series of unpalatable choices.

If State provision is to be improved, we will have to work into our late 60s and beyond. We must also accept that we will have to pay higher taxes or face an impoverished retirement.

Moreover, if we work in the private sector, the Government will have to consider making us save for our pension by introducing an element of compulsion.

Escaped responsibility

FOR much of the post-war period, successive Governments have escaped lightly the burden of pension provision compared with most of our international competitors. Even free enterprise American governments have built up a generous earnings-related State pensions system.

British Governments have escaped responsibility by shifting pension provision to private employees. Indeed, the 'gold standard' of the defined benefit pension - under which people earned benefits for every year worked - covered more than 60% of the workforce.

But now, in seven short years of Labour misrule, the deal between Government and the private sector has been seriously undermined. No longer can the Government count on private sector schemes to bail them out. As Adair Turner and his Commission admit, the defined benefit scheme is dying in the private sector.

Contributions to the replacement scheme, known as defined contribution or money purchase, are wholly inadequate to make up the shortfall in private pensions.

As a result, unless there are fundamental changes in the way in which we pay for retirement, an ever larger and greying population will become dependent on State provision.

How did this disaster befall us? The first explanation would be laughable were it not so serious.

Figures from the Government Actuary's Department show that men and women are living longer. It says something about the short-termism of Government thinking that it has taken so long to make this admission.

Thatcher action

A SECOND factor is the change in the tax status of company pension funds. The crumbling in the tax benefits began in 1986 under Margaret Thatcher when private pension funds, which were building large war chests for future provision, were told that the surpluses could be no more than 5% of the pension funds.

But it was Gordon Brown who finally slaughtered the pensions golden goose. His decision to remove the tax relief on dividends cost the pensions industry £5bn a year.

According to Tom Bower in his new biography of the Chancellor, this decision ignored actuarial advice which predicted that the change would lead to a £50bn deficit in company schemes. At present, the deficit among the FTSE-100 companies has been calculated as high as twice that figure.

This Treasury attack is now regarded as one of the main factors which contributed to £250bn being wiped off share values between 1999 and 2002, bringing an end to what the Commission calls the period of 'irrational exuberance' in share markets. The truth is that pension and insurance fund investments have never recovered from this 'bear market'.

Indeed, an analysis by the free market think-tank the Centre for Policy Studies shows that despite the economic stability delivered by Brown, shareholders have had a torrid time.

While investors in seven major overseas markets have benefited from an average gain of 46% in share prices since May 1, 1997, the gain for British investors in the FTSE-100 has been a mean 2.1%.

Many experts attribute this underperformance to the shadow cast over investment in shares by the Chancellor's tax raid. The result is that big pension funds such as Boots have put their money in lower-risk bonds and reduced the returns on share investment.

Funds devastated

THE RESULT of the tax raid and stock market weakness has been devastating for private sector pension funds. As the report notes, 'the scale of the reversal, its sudden acceleration has major adverse consequences for the adequacy of the UK pensions system'.

Meanwhile, in public pensions, the Government has, by most accounts, compounded the error in the private sector by its creation of an over-complex system of State means-tested 'pensions credits'.

The noble idea of this system is that no retiree, including those with modest savings, should have to fear a poverty-stricken future. But this system of credits is so generous that it has encouraged more people to become dependent on State handouts and given them little incentive to save.

Anybody earning less than £30,000 a year might as well rely on the benevolence of the pensions credit, financial experts say, rather than save in an inferior personal pension plan.

This stupidity must be stopped, and one way of eliminating it is by offering greater incentives to save. One proposal, popular in the financial community, is based on the principle 'buy-one-get-one-free' or BOGOF, under which every pound saved by an employee would be matched by £1 from the Government.

No commitment

THIS MIGHT replace the current system of tax reliefs, which most people find too complicated to understand.

Other ideas include the 'opt in' pension under which employers would be obliged to put their workers into a company pension scheme, unless the workers specifically signed a legal contract saying they wanted out.

Many experts are concerned that this might not work because many medium and smaller firms do not at present have their own pension funds. That is why the Australian option of compulsion is under close consideration by the Commission.

Down Under, all employers are required to pay in 9% to a private pension plan for each worker and the employees themselves contribute 2% to 3%.

Whatever solution is finally adopted, the pensions crisis looks as if it will become worse before it improves. For there is no immediate commitment by any political party to roll back the tax raid which has undermined Britain's stock market and the private savings culture.

Above all, the most galling prospect for the hard-working population of this country is that the very people taking pensions decisions on our behalf are themselves the most protected.

Inflation-proofed, defined benefit pensions for politicians and the public sector are an entrenched privilege.

Yesterday's report reveals that the Government has dug itself into a pensions black hole. Now it is asking taxpayers to dig it out of trouble.

But reform can only work if it recreates the tax incentives to save and rekindles the dynamism of the share markets which underpinned private pension provision for decades.